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Rural Finance – Module 8 Agenda
Block 1
• Introduction
• Risk analysis of agriculture and rural loan portfolio: the art of risk analysis
• Type of risks
• Portfolio risk management
Block 2
• Measuring portfolio quality: Portfolio quality ratios
Coffee Break
Block 3
• Strategies for active loan portfolio management
Block 4
• Credit Enhancements and Credit Guarantees
• Guarantee Funds
Block 5
• Review of the day by a participant volunteer
• Daily evaluation
• Readings for next day
Rural Finance – Module 8 AgendaBlock 1
• Introduction• Risk analysis of agriculture and rural loan portfolio: the art of
risk analysis• Type of risks• Portfolio risk management
Block 2
• Measuring portfolio quality: Portfolio quality ratios
Coffee Break
Block 3
• Strategies for active loan portfolio management
Block 4
• Credit Enhancements and Credit Guarantees
• Guarantee Funds
Block 5
• Review of the day by a participant volunteer
• Daily evaluation
• Readings for next day
The Art of Risk Analysis
The 5 Cs are Important Factors for Analyzing
Credit Risk, but –
• The “art” is much more than knowing how to do
calculations! It is smelling, intuition and
emotional intelligence!
• Good risk management depends on knowing
which, when and how to apply analysis
indicators and also how to analyze the social
and personal factors of the borrower.
Rural and Agricultural Costs and Risks
Transaction Costs
Loan Terms
Cash Flow & Income Regularity
Co-variant Risk
Collateral Assessment Skills
Social Assessment Skills
Agricultural Technical Understanding
Market Assessment Understanding
Rural
Agricultural
Non-
Agricultural
Urban
High Low
High
Low
Managing Client Credit Risk
Financial investment outcomes are uncertain –
they can be relatively safe, unsure or risky
• Certainty is when only one outcome is
possible, or the outcomes are known
• Uncertainty refers to an expected future
outcome which is unknown even though
the probability of occurrence and the
actual magnitude are known
• Risk identify the existence of the
probability of an adverse outcome
Portfolio Risk Management
• Portfolio Risk Categories (source: Ag.Toolkit
ch.4)
Risk category Source of information on the
risk profile
Source of information for
the risk exposure of the
financial institution
Regional risk Reports from provincial
government
Past performance per region
Sector risk Ministry of Agriculture, Ministry
of Small Industries, Chambers of
Commerce, Agricultural
Extension Services
Internal information sources
Past performance per sector
and product
Loan terms
concentration
risk
Internal information sources
Long term analyses of financial
sectors
Past performance per loan
term category
Regional Risk
• Factors influencing regional risk
Regional Risk
Socio-demographic
conditions
Macroeconomic
conditions
Geographic conditions
(e.g. microclimates)
Ecological conditions
Infrastructure
conditions
Political
conditions
Sector Risk
• Factors influencing Sector risk
Sector Risk
Market structure
risks
Exposure to
macroeconomic risks
Expected sector
growth
Expected sector
profitability
Loan Concentration Risk
• The loan concentration risk primarily refers to the risk that the loan portfolio is concentrated in very few, large loans
• If one loan fails, this would have a very strong overall impact on the loan portfolio quality
• By the same token, allowing that a considerable portion of the loan portfolio is comprised of loans with similar features (e.g. all loans fall due in the same month), can also represent a considerable loan concentration risk
Rural Finance – Module 8 Agenda
Block 1
• Introduction
• Risk analysis of agriculture and rural loan portfolio: the art of risk analysis
• Type of risks
• Portfolio risk management
Block 2
• Measuring portfolio quality: Portfolio quality ratios
Coffee Break
Block 3
• Strategies for active loan portfolio management
Block 4
• Credit Enhancements and Credit Guarantees
• Guarantee Funds
Block 5
• Review of the day by a participant volunteer
• Daily evaluation
• Readings for next day
Measuring Loan Portfolio Quality
Loan Portfolio at Risk
• The loan portfolio at risk is defined as the value of the
outstanding balance of all loans in arrears (principal). The Loan Portfolio at Risk is generally expressed as a
percentage rate of the total loan portfolio currently
outstanding.
Total outstanding balance of overdue loans
Total outstanding loan portfolio
Loan Portfolio at Risk and Sector Distribution
example (Ag. Toolkit ch. 4)
In USD or % Total Outst. Loans
% Loan Portfolio at Risk
%
Coffee 284.000 14,2% 40.775 23,3%
Wheat 278.000 13,9% 22.225 12,7%
Rice 214.000 10,7% 19.600 11,2%
Maize 106.000 5,3% 16.450 9,4%
Vegetable 326.000 16,3% 14.875 8,5%
Cattle 196.000 9,8% 26.775 15,3%
Pigs 62.000 3,1% 5.600 3,2%
Poultry 48.000 2,4% 4.025 2,3%
Services 126.000 6,3% 8.575 4,9%
Trade 360.000 18,0% 16.100 9,2%
TOTAL 2.000.000 100,0% 175.000 100,0%
Measuring Loan Portfolio Quality
Loan Loss Rate• The loan loss rate refers to the amount of loans
that has actually been written off during a specific
period of time. These are explicit losses that an institution has acknowledged because there is no
possibility to recover or enforce the loan. In a large number of institutions, the loan loss rate is
calculated on an annual basis.
Amount written off during period n
Average outstanding loan portfolio during period n
Loan Loss Rate and Sector Distribution
example (Ag. Toolkit ch. 4)
• The following table summarises the loan loss ratios as
percentages of each sector portfolio.
% of av. sector loan p. 1997 1998 1999 2000 2001
Coffee 3,2% 3,1% 3,0% 5,1% 5,9%
Wheat & Rice 2,9% 2,4% 2,2% 2,2% 2,1%
Maize 5,3% 5,4% 16,0% 5,1% 5,3%
Vegetable 0,8% 0,7% 0,6% 0,6% 0,6%
Cattle, Pigs & Poultry 1,5% 1,3% 1,4% 1,5% 1,3%
Services & Trade 0,2% 0,2% 0,1% 0,1% 0,2%
TOTAL 2,3% 2,2% 3,1% 2,4% 2,5%
Measuring Loan Portfolio Quality
• Portfolio quality: SEEP ratios (example)
R9 Portfolio at Risk (PAR) Ratio Adjusted PAR Ratio
PAR > 30 Days + Value of Renegotiated Loans Gross Loan Portfolio PAR > 30 Days + Value of Renegotiated Loans Adjusted Gross Loan Portfolio
The most accepted measure of portfolio quality. The most common international measurements of PAR are > 30 days and > 90 days. The adjusted PAR reduces the Gross Loan Portfolio by the Write-off Adjustment.
R10
Write-off Ratio Adjusted Write-off Ratio
Value of Loans Written Off Average Gross Loan Portfolio Value of Loans Written Off + Write-off Adjustment Average Adjusted Gross Loan Portfolio
Represents the percentage of the MFI’s loans that has been removed from the balance of the gross loan portfolio because they are unlikely to be repaid. MFIs’ write-off policies vary; managers are recommended to calculate this ratio on an adjusted basis.
R11 Risk Coverage Ratio Adjusted Risk Coverage Ratio
Impairment Loss Allowance Portfolio at Risk > 30 Days Adjusted Impairment Loss Allowance Adjusted Portfolio at Risk > 30 Days – Write-off Adjustment
Shows how much of the portfolio at risk is covered by the MFI’s Impairment Loss Allowance. The adjusted ratio incorporates the Impairment Loss Allowance Adjustment and the Write-off Adjustment.
Rural Finance – Module 8 AgendaBlock 1
• Introduction
• Risk analysis of agriculture and rural loan portfolio: the art of risk analysis
• Type of risks
• Portfolio risk management
Block 2
• Measuring portfolio quality: Portfolio quality ratios
Coffee Break
Block 3
• Strategies for active loan portfolio management
Block 4
• Credit Enhancements and Credit Guarantees
• Guarantee Funds
Block 5
• Review of the day by a participant volunteer
• Daily evaluation
• Readings for next day
Strategies for Active Loan Portfolio Management
• Exclusion of certain regions and economic
sectors from accessing loans
• Inclusion of certain sectors or regions only under
specific conditions
• Sector and regional limits
Strategies for Active Loan Portfolio Management:
-Sector and regional limits-
Crops Lower limit Upper limit
Coffee 5% 10%
Wheat 10% 20%
Rice 10% 15%
Maize 5% 10%
Vegetable 10% 20%
Cattle 5% 10%
Pigs 2% 5%
Poultry 2% 5%
Services 5% 15%
Trade 10% 30%
Let’s see how AGLEND has defined the upper and lower limits for
various economic sectors (example in AgToolkit ch. 4)
Strategies for Active Loan Portfolio Management
• Delegation of loan decision-making to higher levels
• Preference to loan renewals
• Stricter borrower selection criteria
• Increased collateral requirements
Strategies for Active Loan Portfolio Management
• Risk premium
• Limits for individual loans
• Write-off policies
• Differentiated loan monitoring
• Provisioning
• Credit derivatives
Strategies for Active Loan Portfolio Management:
-Provisioning-
The provisioning rates normally take into
account:
• The number of days in arrears
• The loan maturity and repayment frequency
• The quality of collateral
• AGLEND applies the following loan provision policy (example in AgToolkit ch. 4)
Days with overdue payments Provisions
I. Normal 0 days 2-5%
II. Watch < 30 days 25%
III. Sub-Standard 30 – 90 days 50%
IV. Doubtful 90 - 180 days 75%
V. Loss > 180 days 100%
Strategies for Active Loan Portfolio Management:
-Provisioning-
Portfolio Diversification:Credit Derivatives
The protection buyer sells the credit risk
inherent a certain obligation (reference
obligation) to a third party (protection
seller) without transferring the ownership of
the credit title.
••Credit Credit defaultdefault swapsswaps
••Credit Credit spreadspread productsproducts
••Total Rate of Return Total Rate of Return SwapsSwaps
••Credit Credit linkedlinked structuredstructured notesnotes
Types of Credit Derivatives
Credit Default Swap:
PROTECTION
BUYER
PROTECTION
SELLER
Periodical payment as a % on the contract amount
Payment upon the credit event
Strategies for Active Loan Portfolio Management
EXERCISE:
• Rabobank credit control: an example
• Rabobank exposure management paper: an
example and application to a bank report
Rural Finance – Module 8 Agenda
Block 1
• Introduction
• Risk analysis of agriculture and rural loan portfolio: the art of risk analysis
• Type of risks
• Portfolio risk management
Block 2
• Measuring portfolio quality: Portfolio quality ratios
Coffee Break
Block 3
• Strategies for active loan portfolio management
Block 4
• Credit Enhancements and Credit Guarantees• Guarantee Funds
Block 5
• Review of the day by a participant volunteer
• Daily evaluation
• Readings for next day
Credit Enhancements and Credit Guarantees
Definitions
Credit Enhancement:
The process of reducing credit risk by requiring
collateral, insurance, guarantees or other
agreements to provide the lender with
reassurance that it will be compensated if the
borrower defaulted.
Credit Guarantee:
A promise made by a third party to pay in the
event of default by the borrower
Credit Enhancements and Credit Guarantees
Glossary point
A guarantee is a promise to pay. Collateral is a pledge of goods to ensure payment. A guarantee may be collateralized, or may be unsecured.
In several languages guarantee is used interchangeably to mean collateral as well as a promise to pay.
Credit Enhancements andCredit Guarantees
Reasons for Providing Credit Guarantees
• Promote private sector lending – reduce credit risk
• Build lending capacity and potential for sustained activity
• Leverage funding from private sources
• Address market imperfections, not distort markets
Guarantee Funds: The Relevant Theory
• Guarantee funds help banks in the process of approaching market segments which they are not used to work with and they consider too risky.
• This perception of high risk often derives from a lack of knowledge of these segments by the banks.
• Typical case: rural entrepreneurs
Some Questions
How should a guarantee fund work? (GROUP WORK)
�Who should take the risk?
�In which percentage?
�Who should evaluate the risk?
�How much would the protection cost?
�Who should be the owner of a g.f.?
�How do I measure the effects?
The Basic Scheme
Borrower Guarantee
fundBank
Operating costs
Risk
identification
Risk analysis
and evaluation
Pricing
Control
Risk premium Risk taking
Risk free cost of
fundsFunding
Masini,
2004
Guarantee Funds:The Typology
• individual models/retail
• portfolio models
• wholesale/intermediation models: the fund guarantees the loans that a bank grants to a micro-finance intermediary
• constitution, in a bank, of a deposit account covering certain types of loans
• mutual agreements among producers
• public and private institutions, domestic or international
Guarantee Funds: The Relevant Theory
• Banks go through a learning process in their
relationships with new customers
• Guarantee funds can be considered as
“knowledge facilitators”.
Guarantee Funds: The Relevant Theory
The effects of guarantee funds may be:
• an increase in the offer of bank loans to the
• target sector (additionality);
• better conditions on the loans
• a reduction in collateral requirements
Guarantee Funds: The Relevant Theory
Main criticisms:
• transaction costs which can be increased rather than reduced;
• the guarantee fund is a form of subsidy which distorts the market;
• moral hazard (on the bank and on the borrower);
• a duplication of functions between the fund and the bank
• a problem of sustainability of the funds
Lessons Learnt And Recommendations
• Role of the guarantee fund is not to complement the collateral but, rather, to encourage banks to get to know a market segment
• If the information gap is the major problem, once banks get to know this sector, they should not need the guarantee system any longer
• This is the real additionality effect that should be expected from a guarantee fund.
• Banks should be willing to build long-lasting relationships with new market segments, as a part of their strategy.
• If this expansion is imposed (social objectives pursued by the Government), more risk of moral hazard
Lessons Learnt and Recommendatins
the percent coverage should vary according to
the responsibility taken by the bank and
should not be uniform on all customers
the fund must offer a real advantage to the
beneficiary but risk of moral hazard if the
beneficiary is aware of the guarantee
Some Further Analysis
Functions of guarantee fund:
- Support the bank in risk evaluation (perform
credit analysis)
- Insurer (does not perform credit analysis)
- Advice, rating, training
Rural Finance – Module 8 AgendaBlock 1
• Introduction
• Risk analysis of agriculture and rural loan portfolio: the art of risk analysis
• Type of risks
• Portfolio risk management
Block 2
• Measuring portfolio quality: Portfolio quality ratios
Coffee Break
Block 3
• Strategies for active loan portfolio management
Block 4
• Credit Enhancements and Credit Guarantees
• Guarantee Funds
Block 5
• Review of the day by a participant volunteer• Daily evaluation• Readings for next day